Stock options for corporate management have come under increasing fire on Capitol Hill since last year’s Enron debacle. It’s important to understand the importance of stock options as a tool for shareholders as well as the responsibility of corporate management to account for stock options in a full and honest manner.
Stock options play an important role for the owners of a corporation – its shareholders. They help overcome an agency conflict, where management, as agents of the owners, behaves in its own self-interest, which is not always consistent with that of the shareholders.
It is a fact of basic human nature that we all tend to behave in our own self-interest. Issuing stock options to managers makes them shareholders as well. That way, when managers behave in their own self-interest, they are also behaving in the interest of all shareholders. Eliminating stock options for management would leave shareholders with no effective means of overcoming this agency conflict.
A major battle has developed on Capitol Hill over how corporations should account for the cost of stock options. Large corporations who routinely issue stock options are on one side of the issue, and a most unlikely group of advocates, including billionaire Warren Buffet, Senator Carl Levin, Senator John McCain and Federal Reserve Chairman Alan Greenspan are on the other.
The issue is that presently, corporations list stock options as an expense for tax purposes, but do not list options as an expense on the corporation’s financial statements. Critics argue that stock options have a cost associated with them, so ignoring this cost has the effect of understating expenses and overstating corporate net income. Those affected most by this policy ar ...